Coal Quarterly – July 2005 Gerard Burg Contract prices to ease as supply expands

· · ·

Contract prices for thermal and metallurgical coal rose dramatically in response to surging demand from Asia and supply constraints in key producing nations. Rail and port constraints in 2004 restricted exports from Port Waratah at Newcastle, Dalrymple Bay in Queensland and Richards Bay in South Africa. Infrastructure constraints will continue to restrict Australian coal exports in the short term, however expansions are scheduled at Australia’s major coal export ports. These expansions will add downward pressure to coal prices as Australian producers respond to Asia’s coal demand. For the 2005 Japanese financial year, contract prices for hard coking and semi-soft coking coal rose by 119 per cent and 100 per cent respectively. In comparison, thermal coal prices rose by ‘just’ 18 per cent. Only hard coking coal is expected to rise in price for the 2006 financial year, reflecting the relative scarcity of high rank coal. Contract prices are forecast to decline over the medium term as expansions to port and rail infrastructure reduce export constraints and new production capacity is brought online.

China’s domestic coal demand impacts global trade ·

·

·

·

China is the world’s largest producer and consumer of coal. In 2004, China produced an estimate 1.9 billion tonnes of coal, around 32 per cent of global output (Barlow Jonker). Rapid growth in electricity generation and steel production has strained domestic coal supply and infrastructure, restricting China’s ability to satisfy both domestic and export demand. Total coal exports from China are forecast to remain around 80 million tonnes – the current level of licenced exports – over the medium term. However, there is downside risk to this projection as domestic requirements continue to rise. China is expected to become an increasing net importer of metallurgical coal, as the country lacks sufficient reserves of high grade coking coal to satisfy the requirements of its growing steel industry.

Australia to take a greater share of global trade · · ·

Expansions to export infrastructure and substantial high quality reserves are forecast to result in Australia’s share of global trade increasing over the medium term. Australia’s share of thermal coal trade is forecast to increase from almost 20 per cent in 2004 to 22 per cent in 2010. Australia already dominates metallurgical coal trade, and its share of trade is forecast to increase from 53 per cent in 2004 to 61 per cent in 2010.

Gerard Burg Economist Minerals & Energy (613) 8641 3984 [email protected]

Figure 1: Coal contract prices – constraints drive prices to (nominal) highs US$/t 140

Hard

Semi-soft

Thermal

120 100 80 60 40 20

19 9 19 7 98 19 9 20 9 00 20 0 20 1 0 20 2 03 20 0 20 4 05 20 0 20 6 0 20 7 08 20 0 20 9 10

·

Source: ABARE, Group Economics

Table 1: Coal forecast summary - global 2004

2005

2010

Total trade - Mt Thermal Metallurgical

543.4 216.5

550.1 221.0

Contract prices – US$/t Thermal 45 52.5 Hard coking 57 125 Semi-soft coking 41 85 Source: Barlow Jonker, ABARE, Group Economics

Jeff Oughton Head of Economics Australia (613) 8641 3469 [email protected]

603.0 261.6 35 65 37.65

Infrastructure – the short term constraint Vessel queues at the Australian ports of Newcastle and Dalrymple Bay in 2004 highlighted constrained coal export infrastructure – at every level from mines through rail and ports – under high demand conditions. In response to constraints, port and rail operators in New South Wales and Queensland have developed plans to expand infrastructure. However, in the short term coal demand remains strong and infrastructure continues to constrain Australian coal exports. Coal producers and infrastructure providers have developed plans to expand the capacity of the Hunter Valley coal chain to around 102 million tonnes a year by late 2007, compared with exports of 79 million tonnes in 2004. Further expansions, including a third coal terminal at Newcastle, are likely to be required by 2010.

-5

100

-10

0

-15

Source: ABARE, Group Economics

Strong economic growth and scheduled expansions in coal-fired electricity generation capacity are expected to drive increased thermal coal imports in South Korea. Electricity generators are proposing to add around 8 gigawatts of capacity by 2010. Imports are forecast to increase by around 5 per cent a year to 79 million tonnes in 2010, compared with an estimated 60 million tonnes in 2004. The majority of growth in Taiwan’s electricity generation is expected to be gas-fired, given government incentives to encourage LNG imports. Some growth in coal-fired generation is expected, increasing by around 0.6 gigawatts by 2010. Taiwan’s thermal coal imports are forecast to increase by 2.7 per cent a year to 60 million tonnes.

Figure 3: Key thermal coal importers Mt

The Queensland government has committed to expand the port of Gladstone to 63 million tonnes a year by 2007, an increase of around 13 million tonnes. To support both port expansions, the government has also announced plans to upgrade the rail networks that support the ports.

0

Growth in thermal coal imports is driven by a number of key consuming countries, primarily in Asia, underpinned by increased coal-fired electricity generation capacity. The key growth consumers are not signatories to the Kyoto Protocol.

©2005 National Australia Bank Limited ABN 12 004 044 937

20 08

0

200

20 05

5

300

20 02

400

19 99

10

19 96

15

500

19 93

600

In Queensland, expansions are scheduled at the privately owned Dalrymple Bay Coal Terminal as well as state owned Gladstone. Dalrymple Bay is currently increasing capacity to 60 million tonnes a year by early 2006, an increase of 5.5 million tonnes. Beyond this level, the port’s operators plan to spend around $1.1 billion to expand capacity to 85 million tonnes a year by mid 2008.

Global trade of thermal coal is forecast to increase by 1.2 per cent to 550 million tonnes in 2005. By 2010, thermal coal trade is forecast to reach 603 million tonnes.

%

% change

20

160

Thermal coal – Asia drives modest growth in imports

Thermal coal trade

700

19 90

China is expected to have a major influence on coal markets. Surging domestic demand from electricity generators and steel producers has curtailed coal exports and has led to increased imports, particularly of high rank metallurgical coal.

Mt

19 87

The outlook for black coal supply varies across grades. Prices for thermal and semi-soft coking coal are forecast to fall as producers expand output. Prices for relatively more scarce hard coking coal are forecast to increase for the 2006 Japanese financial year, before declining in the medium term.

Figure 2: Environmental concerns to slow thermal coal trade

19 84

Spot and contract prices for black coal have risen sharply since early 2003. Strong demand for black coal, driven by primarily by economic and industrial production growth in Asia, coupled with supply constraints and disruptions in major producing nations drove prices significantly higher.

19 81

Overview

Japan

Taiwan

EU 25

Ko rea

140 120 100 80 60 40

19 97 19 98 19 99 20 00 20 01 20 02 20 0 20 3 04 20 05 20 06 20 07 20 08 20 09 20 10

20

Source: Barlow Jonker, ABARE, Group Economics

The Malaysian government has encouraged the development of coal-fired electricity generation in an effort to diversify the country’s fuel mix. Thermal coal imports are forecast to increase by over 12 per cent a year to reach 20 million tonnes in 2010, up from around 10 million tonnes in 2004. In contrast, growth in Japan’s thermal coal imports is expected to be more subdued. Japan is expected to experience lower economic growth over the same period and environmental concerns are likely to limit expansions to coal-fired electricity generation. Thermal coal imports in Japan are forecast to increase 1.5 per cent a year to

2

120 million tonnes in 2010. However, public opposition to nuclear power adds some upside risk to this forecast. Similar environmental concerns are likely to reduce thermal coal imports in the European Union. Kyoto Protocol emission targets are expected to result in an increased penetration of natural gas into European electricity generation. Thermal coal imports in the European Union are forecast to fall by around 4 million tonnes to 154 million tonnes in 2010.

Thermal coal exporters – Indonesia the key producers

Australia

and

The majority of Australia’s thermal coal exports are from the Hunter Valley in New South Wales. Rail and port infrastructure constraints restricted the ability of coal producers to respond to soaring demand in 2004. Despite plans to expand the capacity of the entire coal chain, these constraints are likely to restrict thermal coal exports in the short term. Australian thermal coal exports are forecast to reach 132 million tonnes in 2010. Indonesia exceeded China as the second largest thermal coal exporter in 2003. Indonesia’s exports are likely to approach the same level as Australia’s in 2005, however increased domestic consumption over the medium term is expected to slow export growth. Higher export potential depends on consumer acceptance of lower rank subbituminous coal that accounts for a significant proportion of Indonesia’s coal reserves. Exports of thermal coal are forecast to increase to 125 million tonnes in 2010.

Figure 4: Australia and Indonesia drive thermal coal export growth Mt 160

Australia

South Africa

China

Indonesia

140 120

high production costs and an unfavourable exchange rate. Exports are forecast to reach 80 million tonnes by 2010. Colombian exports are expected to grow by around 3 per cent a year to 64 million tonnes. The Panama Canal restricts vessel sizes for potential Colombian exports to Asia. Therefore the majority of expanded Colombian thermal coal exports are expected to be delivered to European consumers.

Thermal coal prices – easing supply constraints to drive prices lower Contract prices for thermal coal rose sharply for the 2004 and 2005 Japanese financial years, driven by strong demand and constrained supply. Supply pressures are expected to ease in 2006, as port expansions increase the quantities of thermal coal available to seaborne markets. Prices for the 2006 Japanese financial year are forecast to fall by 9 per cent to US$48 a tonne (for calorific value 6700 kcal/kg gross air dried). Over the medium term, growth in thermal coal demand is forecast to ease – as economic growth slows from high levels – while supply constraints are expected to diminish. As a consequence, contract prices for thermal coal are forecast to fall over this period, to around US$35 a tonne in 2010.

Figure 5: Australia-Japan thermal coal contract prices US$/t 60 50 40 30 20

80

19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10

100 60

Growth from exporters that predominately supply Europe is forecast to be more modest. South African exports remain constrained by port and rail disruptions as well as ©2005 National Australia Bank Limited ABN 12 004 044 937

% change trade

% change price

60 40 20 0

20 10

20 07

20 04

20 01

19 98

-20

19 95

China’s consumption of thermal coal will have a major influence on global coal trade and prices. China is the world’s largest producer of coal, though the country’s rapid economic expansion has stretched its ability to meet both domestic and export demand. Statements by the National Development and Reform Commission indicate that China wishes to maintain a stable role in global coal markets. China’s total coal exports are forecast to remain static at around 80 million tonnes over the medium term. However, reductions to export incentives and increased incentives to import coal imply some downside risk to this forecast.

% 80

19 92

Source: Barlow Jonker, ABARE, Group Economics

Figure 6: Increased global exports to bring down prices

19 89

19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10

0

Source: ABARE, Group Economics

19 86

20

19 83

40

Source: ABARE, Group Economics

Metallurgical coal – steel the driver Expansions in blast furnace steel production are expected to underpin growth in metallurgical coal trade. Significant growth in steel production is occurring in

3

countries that possess little or no high quality metallurgical coal. Global metallurgical coal trade is forecast to increase by 2.7 per cent in 2005 to around 222 million tonnes. Into the medium term, metallurgical coal trade is projected to increase by 3.2 per cent a year to reach 253 million tonnes.

Figure 7: Steel production drives strong growth in metallurgical coal Metallurgical coal trade

%

% change

300

15

275

10

20 08

20 05

-15

20 02

150

19 99

-10

19 96

-5

175

19 93

200

19 90

0

19 87

225

19 84

5

19 81

250

Mt

Demand for metallurgical coal is likely to be tempered by efficiency improvements over the medium term, both in the manufacturing of coke and increasing use of pulverised coal injection (PCI). Continued growth in steel production in China is expected to lead to increased metallurgical coal imports. Although China has significant semi-soft coking coal reserves, there are limited reserves of high quality metallurgical coal. China’s imports of metallurgical coal are forecast to increase by over 20 per cent a year to 21 million tonnes in 2010, up from around 6 million tonnes in 2004. Like China, India has significant reserves of low rank coals and will require imported metallurgical coal for its growing steel industry. Indian demand for steel is expected to be driven by construction and infrastructure development required to support its strong economic growth. India’s metallurgical coal imports are forecast to increase by 12 per cent a year to 26 million tonnes.

Figure 8: Metallurgical coal imports industrialising countries lead the way Japan

India

The outlook for metallurgical coal exporters The majority of the growth in metallurgical coal exports is expected to be from Australia and Canada. Producers such as the United States and China are forecast to decrease exports of metallurgical coal, due to high costs and domestic demand respectively. Although the Russian Federation has significant metallurgical coal reserves, infrastructure constraints and an uncertain investment climate is likely to restrict coal exports.

Figure 9: Australia the key met coal exporter

Source: ABARE, Group Economics

Mt

In contrast, Japan’s blast furnace production of steel is forecast to remain stable as Japanese steel exporters lose market share to emerging producers. Imports of metallurgical coal are forecast to remain at around 67 million tonnes in 2010.

EU25

Brazil

–

China

80 70 60 50 40

Australia

Russia

Canada

US

160 140 120 100 80 60 40 20 0

19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10

Mt

European and Chinese companies in the country’s steel industry. Brazil produces around 6 million tonnes of hard coal a year. Therefore to support this growth, metallurgical coal imports are forecast to increase by 8.5 per cent to reach 29 million tonnes in 2010.

Source: Barlow Jonker, ABARE, Group Economics

Australia’s metallurgical coal exports are primarily from Queensland. A number of new developments and expansions at existing mines are currently proposed to expand metallurgical coal production and exports. Queensland’s two largest ports, Gladstone and Dalrymple Bay, are also expanding to accommodate the expected increase in exports. Australia’s metallurgical coal exports are forecast to increase to 160 million tonnes in 2010. Canada’s metallurgical coal is typically lower quality than its Australian equivalent and has a higher delivered cost. However, new PCI mines and the resumption of mothballed capacity is expected to increase Canada’s metallurgical coal exports over the medium term. Canada’s exports are forecast to reach 37 million tonnes in 2010, an increase of 6 per cent a year.

30 20 10

19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10

0

Source: Barlow Jonker, ABARE, Group Economics

Metallurgical coal prices Surging steel production in Asia in recent years drove benchmark prices dramatically higher, with hard coking coal to Japan rising by 119 per cent for Japanese financial year 2005. Similar gains for semi-soft coking coal were reportedly due to these contracts being tied to hard coking coal, rather than an underlying shortage of supply.

Large reserves of high quality iron ore in Brazil have encouraged joint venture investments between domestic, ©2005 National Australia Bank Limited ABN 12 004 044 937

4

Figure 10: Met coal contract prices to fall US $ / t

Hard

140

Semi-soft

Table 2: Thermal coal trade forecast Total trade – Mt Contract price - US$/t

120

Imports – Mt Asia

100 80

Taiwan Japan South Korea Malaysia Other Asia

60 40 20 19 9 19 7 98 19 9 20 9 0 20 0 01 20 0 20 2 03 20 0 20 4 0 20 5 0 20 6 07 20 0 20 8 09 20 10

Europe

Source: ABARE, Group Economics

Demand for metallurgical coal is forecast to remain strong in Asia, particularly China, while supply of hard coking coal is expected to remain tight in the near term. As a consequence, contract prices for hard coking coal (to be negotiated in six to nine months time) are forecast to rise by 8 per cent to US$135 a tonne. Contract prices for relatively more common semi-soft coking coal are expected to decline as exports increase in Japanese financial year 2006. Prices are forecast to fall 22 per cent to US$66 a tonne.

Figure 11: Metallurgical coal prices to fall as exports rise % 120

% change trade

% change price

100

EU 25 Other Europe Other

Total trade – Mt Contract price - US$/t Hard Semi-soft Imports – Mt Asia

60 40 20

EU25 Brazil Other

20 08

20 05

20 02

19 99

19 96

19 93

19 90

19 87

19 84

19 81

-40

Source: ABARE, Group Economics

Metallurgical coal contract prices are forecast to decline over the medium term as industrial production eases and supply constraints diminish. By 2010, semi-soft coking coal is expected to return to a historical premium over thermal coal, with prices falling to US$37.65 a tonne. Hard coking coal is forecast to decline to around US$65 a tonne by 2010.

©2005 National Australia Bank Limited ABN 12 004 044 937

2010 603.0 35

2004 282.4 51.0 109.6 60.0 10.0 51.8 174.1 157.8 16.3 86.9

2005 286.7 52.6 110.0 60.6 10.4 53.1 175.9 159.0 16.9 87.5

2010 338.4 59.9 119.7 78.9 20.3 59.6 173.1 153.7 19.4 91.5 2010 131.9 78.0 64.3 125.1 80.0 18.0 105.7

Table 3: Metallurgical coal trade forecast

Japan Taiwan S. Korea India China Other Asia

0

2005 550.1 52.5

Exports – Mt 2004 2005 Australia 106.9 110.9 China 79.2 77.6 Colombia 53.5 55.9 Indonesia 103.0 108.5 South Africa 67.0 66.4 US 20.0 18.8 Other 113.8 112.0 Source: Barlow Jonker, ABARE, Group Economics

80

-20

2004 543.4 45

2004 216.5

2005 222.4

2010 261.6

57 41

125 85

65 37.65

2004 117.3 67.0 8.4 19.9 13.9 6.4 1.7 51.3 17.8 30.1

2005 122.9 67.2 8.5 20.2 14.7 10.1 2.2 51.0 18.3 30.2

2010 147.1 67.2 8.8 20.9 25.8 20.6 3.8 53.0 29.0 32.5

Exports – Mt 2004 2005 Australia 115.4 122.9 Canada 25.1 28.1 US 24.6 25.0 China 5.8 2.4 Russia 13.1 13.5 Other 32.5 30.5 Source: Barlow Jonker, ABARE, Group Economics

2010 159.5 36.5 16.3 2.0 14.5 32.8

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Group Economics – Some Useful Contacts by Specialisation Alan Oster Group Chief Economist [email protected] Economic, Financial & Business Conditions Jeff Oughton Head of Australia [email protected] Economic, Financial & Business Conditions Dean Pearson Senior Economist [email protected] Telecommunications, Media, Recreation, Personal Luke Chandler Economist [email protected] Agribusiness John Sharma Economist [email protected] Property, Construction, Transport, Hospitality Ian Gordon Economist [email protected] Healthcare, Retailing, Business Services, Education Gerard Burg Economist [email protected] Minerals & Energy Dean Wickenton Economist [email protected] Manufacturing, Wholesaling Kyran Curry Economist (Australia) [email protected] Economic & Financial Conditions Tom Taylor Head of International [email protected] Economic & Financial Conditions Robert De Iure Economist Robert_De [email protected] Country Risk & Asian Economies Carolyn Fraser Economist (United Kingdom) [email protected] Economic & Financial Conditions

(03) 8641 3464 (03) 8641 3469 (03) 8641 3474 (03) 8641 3442 (03) 8641 3473 (03) 8641 3472 (03) 8641 3984 (03) 8641 3762 (03) 8641 3848 (03) 8641 3475 (03) 8641 3445 (03) 8641 3694

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